Economic Growth, Savings and Gold: Part I

“I am shocked by how government intervention and the sheer size of government have grown in the last 15 years. South Africa is no longer a potential capitalist miracle, as I had hoped it would be, along with places like Hong Kong, South Korea, Singapore and others.”

This might sound all too familiar – a common condemnation by many of today’s pundits, lamenting the ruling party’s inability to deliver, specifically on economic growth, since the turn of our democracy.

This, however, is an excerpt from a newspaper article detailing the visit to South Africa of famed economist, Friedrich von Hayek, in 1978 – some 41 years ago, when apartheid was in full force. Today, 25 years into our democracy, much the same can be said.

But what exactly is economic growth, and how is it that we’re still seemingly losing this battle?

Economic Growth

Economic growth is that seemingly elusive panacea to all our economic troubles.

Modern economists and market pundits roughly distil it into a metric called Gross Domestic Product (GDP) growth and eagerly await official GDP statistics as if, somehow, a nation’s future prosperity rests solely on a favourable figure.

Economic growth comes from the amount of real ‘stuff’ in an economy that can be enjoyed and consumed by people in a society. These real goods and services available to consume improve everyone’s standard of living.

An economy can only grow when more goods and services are produced in relation to a previous time period.

Let’s analyse the factors of economic growth in more depth.

Savings, Investment & Production

Savings form the cornerstone of a growing economy. To elucidate, let’s consider the following analogy…

There were three men on island, namely Adam, Bob and Charlie. All three men fish by hand and catch one fish each per day, enough to sustain them until the following day when they head into the surf again. In this scenario, you would find them consuming that which they produce – in this case, a fishy meal each day.

One day, Adam gets an idea for an invention that might enable him to catch more than one fish – but when will he have time to build it? He spends all his waking hours working to produce food to sustain himself. There is also no assurance that his invention will work.

Adam works up the courage and decides to take a chance on his idea. He tells the others he will forego fishing for one day and devote his time to manufacture a device he calls a ‘net’. Despite dissent from his fellow island goers, Adam proceeds. He foregoes fishing for the day and goes hungry, but actually succeeds in making his net.

The next day, using his new invention, Adam is able to catch two fish – he eats one and saves the other for future consumption. Adam’s genius resulted in something quite nifty – economic growth.

The island’s economy grew by 33% – from three fish a day to four, plus one net. To have achieved this economic growth, Adam had to forego consuming in the present in order to produce more in the future. As such, he had more real goods, in the form of fish, to consume each day.

Not surprisingly, Bob and Charlie want nets too but are unwilling to go hungry while they build them. Instead, they ask to borrow Adam’s net on days when he isn’t using his net, but he turns them down. They then ask him to loan them fish while they build their nets, to which he responds with a proposal to lend them fish with interest — for every fish he lends them they must pay him back two. Bob and Charlie accept Adam’s proposal and the men continue to build their nets…

As you may guess, the result is that the island’s economy grows from 4 fish a day to six – a 50% percent increase in production.

Adam’s fish savings, and his willingness to not consume more fish per day, allows for investment to occur to manufacture two new nets, and for the total production of goods (fish) to increase greatly.

Production Possibilities Frontier

So, in a nutshell: save > invest > produce > consume. This is how an economy grows.

Let’s step it up a level and translate the above basic economic growth analogy into a simple graph – the Production Possibilities Frontier (PPF).

The PPF graph denotes the real goods and services (fish, in our story) that are produced in an economy. The point on the PPF indicates the investment preferences of society in this economy – the ratio of savings invested versus that consumed (fish Adam ate versus those he saved).

Savings in an economy, according to the PPF graph, are allocated to either investment or consumption.

In the case of our island economy, Adam saved and invested, which allowed for the total production of fish to increase on the island.

This growth in the island economy can be depicted in the above PPF. The production frontier is shifting outwards as a result of past investment.

At the higher production frontier, there is now more total resources (fish) that can be consumed as a result of the prudent act of saving and foregoing immediate consumption, resulting in a larger harvest (of fish) for all in the future.

Let’s continue our story and up the ante..

As the island goers’ savings grow, they have more time to undertake other projects. They pool their savings and build a trap that catches 30 fish a week – they never have to fish again!

Adam goes on to start an island clothing company; Bob builds a canoe that he uses to explore other islands with; and Charlie constructs a surfboard to enjoy the island waves with.

Under favourable conditions, a market economy allocates resources to both investment and consumption, making the most of the trade-off. As long as there is savings and investment, the economy should continue to grow.

‘Saving requires us to not get things now, so that we can get bigger ones later.’ Jean Chatzky.

Economic Recession

What could possibly go wrong in our island utopia?

Let’s say that Adam, Bob and Charlie didn’t want to save. In this case, there would be no saved fish to sustain them while they pursue other activities. On the PPF, this would be depicted in the production frontier shifting up. The economy would stagnate as the island goers will have to revert to fishing all day and living a subsistence life of day-to-day toil for mere survival.

Or what if Adam, Bob and Charlie were prevented or discouraged from saving somehow? If you remember, in our previous article we explained that when the currency supply is inflated, society’s savings are eroded and lose value.

As depicted above, the structure of a growing and productive economy weakened at its very foundations as the savings are diminished. This means that there is less resources available in society to invest and produce goods and services that make the economy grow. The economy stagnates, or recedes.

Economic Growth in South Africa

In South Africa, our economic growth prospects keep going from bad to worse. According to official statistics, the South African GDP receded during the first quarter of this year, recording an annualised GDP figure of negative 3.2% – the biggest decline in a decade.

The National Development Plan, adopted in 2012, to guide our national effort in defeating poverty, unemployment and inequality, laid its sights on a utopian SA by 2030. Our president, Cyril Ramaphosa, and those before him, campaigned with the promises of full employment, stables prices and growth, and an end to this dearth of economic growth.

Economists and pundits are fearing that second quarter GDP growth may well come out negative again, and that SA may have fallen into its second recession in as many years (two quarters of negative growth commonly indicate a recession – a period of negative growth and contraction in the economic output).

In terms of our trusty PPF graph, this can be illustrated by the frontier shifting lower – a reduction in the real goods and services available for South Africans to consume and a concomitant drop in our living standards (read: doom and gloom).

So how is it that this vibrant nation of talented, hard-working individuals can fail so dismally, and for so long, to grow the economy? Especially when considering how simple and intuitive our island economy analogy makes growth seem.

In Part II of this article series, we discuss some of the reasons for this, how gold can be a tool to turn this trajectory around by boosting our savings and investment.